The concept of investors aligning their financial goals alongside certain values has been a feature of socially responsible investing for decades. This idea has garnered tremendous interest more recently, leading to a variety of approaches. This paper discusses the evolution of the industry to date and various methods of incorporating Environmental, Social and Governance (“ESG”) considerations in a portfolio.
Corporate Conscience, the Millennial Voice, and Alternative Data: Trends in Sustainable Investing
The quarterly earnings cycle, 24 hour news and constant barrage of social media… it seems with every decade that passes comes an increasingly heightened focus on the “now”. Technology has spurred this transformation, rapidly evolving how people communicate and interact; affecting everything from corporations’ intensified focus on short-term profits over long-term investments, to the soundbites that dominate thoughtful political discourse today. In contrast with this short-termism, a growing number of market participants have pledged to take a long-term view on investing through sustainable initiatives. Whether viewing it through the lens of investment returns, a company’s future viability or an individual’s footprint, “sustainable practice allows us to meet the needs of present users without comprising the ability of future generations to meet their own needs”.2
Growing investor demand has also been fueled by support from leading asset owners and financial institutions, acknowledging their intergenerational commitments and thus having an inherently long-term view. In 2006, 63 investment companies representing $6.5 trillion in assets committed to alignment with the United Nations-supported Principles for Responsible Investment (The PRI), today there are over 2,200 signatories representing over $80 trillion in assets.3 The PRI was predicated on the idea that companies and investors should take into account the implications of their holdings in respect to the world’s environmental, social and governance (ESG) goals. The term ESG covers a wide range of complex and often interrelated issues, such as water management, community relations and board structure.4 Over the years, the PRI has challenged fiduciary responsibility, sparking the conversation on whether non-financial data, such as a company’s ESG characteristics, should be considered in light of investment decisions. Signatories to the PRI commit to incorporating ESG issues into their investment analysis as well as ownership policies and practices. Today, over 73% of investment professionals worldwide surveyed by the CFA Institute consider ESG issues in their investment process.5
Further underscoring today’s changing cultural environment is the Business Roundtable’s recent announcement shifting its mission statement from a focus on shareholder primacy, to instead prioritize and consider multiple stakeholders including customers, employees, suppliers and communities as well as shareholders. In this statement we observe the largest corporations in the United States revising their definition of the purpose of a corporation away from short-term profit maximization to a more holistic and sustainable view of value creation.
Additionally, the millennial generation has been at the vanguard of sustainable investing, demanding more from companies they support and invest in, including greater transparency, a sense of purpose and broader stakeholder and community alignment. 87% of millennials globally believe that the “success of business should be measured in terms of more than financial performance alone.”6 Empowered through one of the largest generational wealth transfers from Baby Boomers, and on the precipice of their prime earning years7, numerous studies suggest that millennials are increasingly interested in deploying capital to those companies viewed as making a positive impact or reflecting personal values. A 2017 FactSet study of high net worth investors states that 90% of millennials want to direct their allocations to responsible investments over the next five years
While it is clear the momentum behind sustainable investing is building, we believe there are many investor considerations in determining how best to meet objectives across financial, environmental, social and governance dimensions.
The Business Case for Sustainability: The Opportunity within Non-Financial Metrics
Investors are becoming increasingly aware that ESG issues can have a measurable effect on a company’s value, as well as its reputation. Data measuring ESG can provide additional insights into potential opportunities or risks outside of traditional financial metrics. Value creation takes place in and depends on environmental, social and governance systems. Economic activity that is not sustainable degrades those systems, diminishing their future viability and value. For instance, future regulation could negatively impact firms that produce high levels of emissions, firms treating employees poorly may face a backlash from consumers or future talent, a firm with inadequate governance may be more likely to be involved in a scandal or controversy.
While the investment professional has a well-developed language and formal system for measuring and assessing the value created, or destroyed, by financial capital, they do not yet have a similarly robust system to assess the value created or destroyed by the use or misuse of ESG capital. However, “what we do have is an evolving language of ESG issues, factors and indicators” (Greis, 2018). The UN PRI Global Compact provides a general framework outlining the three ways in which sustainability through the integration of environmental, social and governance issues can lead to a competitive advantage.8
Asset owners are now asking companies to appreciate, understand and act upon the trade-offs that exist between financial and sustainable performance. Sustainable economic activity maintains or enhances ESG systems, increasing a company’s future viability and value. The future value of the investment depends heavily on the future state of the system.
Values to Value-Based Investing: The Evolving Approaches to Sustainability
The concept of investors aligning their financial goals alongside certain values has been a feature of socially responsible investments (SRI) for decades. However, sustainable investing has evolved considerably from the early SRI funds that primarily looked to exclude certain companies irrespective of financial impact.
Increasingly, investors are looking to take a more active stance with respect to their investments, utilizing a “voice” over “exit” approach in many instances. Shareholder proposals filed at companies requesting enhanced transparency to make investor decisions as well as a means to influence overall change have become a primary pressure tactic. For example, the shareholder proposal process recently helped to drive Dick’s Sporting Goods from selling assault rifles and three years of shareholder resolutions later Exxon gave way and welcomed former atmospheric scientist and director of the Woods Hole Institute to its board. As a result, ISS and Glass Lewis, which provide shareholder proposal guidance, are increasingly influencing how investors’ voices are heard on certain issues.
Broadly speaking, investors tend to group forms of ESG investing into four primary buckets, however many investors look to incorporate multiple methods in order to meet their unique objectives.
Now more than ever, investors are looking to form a deeper and more holistic understanding of financial markets and human behavior to better identify opportunities to create, sustain and protect value while delivering on client objectives. There is a growing need for investment decisions to be considered in a broader context, including risks and opportunities related to environmental, social and governance dynamics which may have long-term benefits on overall investment outcomes. As a firm, we are continuously expanding our research in this area to further refine our understanding of the implementation of alternative insights into the investment process and further explore the impacts of sustainable investing on pricing future risk and return opportunities.
 Michael LaBella is Head of Global Equity Strategy at QS Investors. Dmitry Novikov is Head of Equity Research at QS Investors, Josh Russell is Research Analyst at QS Investors and Lily Sullivan is Equity Strategist at QS Investors. This paper has benefited greatly from useful comments and from discussions with Juliana Bambaci, Janet Campagna, Joe Giroux, Steve Lanzendorf and Russell Shtern.
 As defined by the UN World Commission of Environment and Development Report, 1987
 UN Principles for Responsible Investment Annual Report, 2018
 Gordon L. Clark, Andreas Feiner and Michael Viehs, “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” Arabesque Partners (March 2015).
 CFA Institute, “CFA Institute ESG Survey”
 Harvard Business Review: The Top 10 Sustainable Business Stories of 2017
 The Deloitte Millennial Survey 2018
 United Nations Global Compact Value Driver Model (PRI-UN Global Compact, 2013).
 Khan, Serafeim, and Yoon, “Corporate Sustainability: First Evidence on Materiality”, The Accounting Review 91, 1697-1724, 2016, Dunn, Fitzgibbons and Pomorski, “Assessing Risk through Environment, Social, and Governance Exposures.” 2016
A Quantitative Perspective of how ESG can Enhance your Portfolio 2016, https://yoursri.com/media-new/download/jpm-esg-how-esg-can-enhance-your-portfolio.pdf
Accenture. The “Greater” Wealth Transfer – Capitalizing on the Intergenerational Shift in Wealth, 2012: https://www.accenture.com/us-en/insight-capitalizing-intergenerational-shift-wealth-capital-markets-summary
CFA Institute, “CFA Institute ESG Survey”
Chen, and Mussalli, “Integrated Alpha: The Future of ESG Investing”, April 2018 http://www.panagora.com/assets/PanAgora-Investment-Insight-April-2018-Integrated-Alpha-The-Future-of-ESG-Investing.pdf
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Doyle, “Ratings that Don’t Rate, The Subjective World of ESG Rating Agencies” 2018 http://accfcorpgov.org/wp-content/uploads/2018/07/ACCF_RatingsESGReport.pdf
FactSet’s HNWIs’ Vision for the Wealth Management Industry in the Information Age http://solutions.factset.com/smart-wealth-ebook
Fink, “Purpose and Profits” 2019, https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
Giese, Lee, Melas, Nagy, Nishikawa “Foundations of ESG Investing Part 1: How ESG Affects Equity Valuations, Risk and Performance.” https://www.msci.com/esg-foundations
Gordon L. Clark, Andreas Feiner and Michael Viehs, “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” Arabesque Partners (March 2015)
Harvard Business Review “The Investor Revolution” 2019, https://hbr.org/2019/05/the-investor-revolution
Hawley, Jim “ESG Ratings and Rankings. All over the Map. What Does it Mean?”, TruValue Labs.
Kerber, and Flaherty, “Investing with ‘green’ ratings? It’s a gray area” 2017, https://www.reuters.com/article/us-climate-ratings-analysis-idUSKBN19H0DM
Khan, Serafeim, and Yoon, “Corporate Sustainability: First Evidence on Materiality”, The Accounting Review 91, 1697-1724, 2016
Khan, Serafeim, and Yoon, “Corporate Sustainability: First Evidence on Materiality”, The Accounting Review 91, 1697-1724, 2016, Dunn, Fitzgibbons and Pomorski, “Assessing Risk through Environment, Social, and Governance Exposures.” 2016
Morgan Stanley Institute for Sustainable Investing. Sustainable Signals: The Individual Investor Perspective (February 2015)
Societe Generale “ESG rating and momentum” 2019, https://corpgov.law.harvard.edu/wp-content/uploads/2019/03/esg-momentum_SGCIB.pdf
The Deloitte Millennial Survey 2018
United Nations Global Compact Value Driver Model (PRI-UN Global Compact, 2013). “Why ESG Ratings Will Never Agree And Some Of The Problems Of Ratings”, Then Do Better, September 21, 2018, https://www.thendobetter.com/investing/2018/9/21/why-esg-ratings-will-never-agree-and-some-of-the-problems-of-ratings
The strategy outlined is not currently offered and as such, no clients are invested in this strategy. It is purely hypothetical and the performance returns and other statistics were calculated by QS Investors using published data sources, which have been noted throughout this paper. This material is intended for informational purposes only and it is not intended that it be relied on to make any investment decision. It was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or QS Investors, LLC to enter into or arrange any type of transaction as a consequence of any information contained herein. QS Investors, LLC does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. Except insofar as liability under any statute cannot be excluded, no member of QS Investors, LLC, the Issuer or any officer, employee or associate of them accepts any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person. The views expressed in this document constitute QS Investors’ judgment at the time of issue and are subject to change. Past performance or any prediction or forecast is not indicative of future results. Investments are subject to risks, including possible loss of principal amount invested.
QSCR 18883 (September 2019)